Why Merger and Acquisition (M&A) Waves Reoccur - The Vicious Circle from Pressure to Failure

Why Merger and Acquisition (M&A) Waves Reoccur - The Vicious Circle from Pressure to FailureUlrich Steger and Christopher Kummer IMD 2007-11 Ulrich Steger Alcan Chair of Environmental Management, Program Director, Building High Performance Boards, Global Corporate Governance Research Initiative IMD International 23, Chemin de Bellerive P.O. Box 915 CH-1001 Lausanne Switzerland Tel: + 41 (21) 618 0346 Fax: + 41 (21) 618 0641 E-mail: [email protected] and Christopher Kummer Professor Webster University Berchtoldgasse 1 A-1220 Vienna Austria Tel: +43 (1) 26 99 29 30 Fax: + 43 (1) 269 92 93 13 E-mail: [email protected] Copyright © Ulrich Steger and Christopher Kummer July 2007, All Rights Reserved -0- Why Merger and Acquisition (M&A) Waves Reoccur The Vicious Circle from Pressure to Failure Table of Contents 1 Introduction 2 Why Companies and Managers Choose M&As 2.1 2.2 2.3 The quest for growth and the pressure to grow Being a consolidator Testimonials and success stories 3 Why M&A Deals Fail 3.1 3.2 3.3 3.4 3.5 Unrealistic expectations (Over)Confidence Promoters and external advice Distrust Group dynamics 4 How M&A Failures are (Mis)Interpreted 4.1 4.2 4.3 Internal attributions External attributions Failures as near wins 5 Why Companies are Convinced and Try Again 5.1 5.2 5.3 5.4 5.5 It’s the same aims New concepts and strategies Divert from other M&A deals Serial acquirers Overemphasizing the positive deals and aspects 6 The Vicious Circle from Pressure to Failure 7 Can the Vicious Circle be Broken? -1- 1 Introduction Merger and acquisition (M&A) activity is close to breaking new records and (see fig. Ali-Yrkkö 2002. We should note how little transparency exists when evaluating the success or failure of M&A transactions and that each method used has clear disadvantages. Most studies stop at examining the success or failure rate of M&As and one or two obscure success factors. Bower 2001. This development contradicts the fact that most M&As are considered to be unsuccessful. at how difficult it seems to be to succeed in M&A transactions. the conclusion also depends on the perspective that is taken – whether the target’s shareholders’ gains are included in the calculation. Agrawal et al. Mitchell & Stafford 2000. We are interested in the following question: Why do M&As continue to take place. Even setting aside the issue of different measurements of success and the many methods around. 1992. their management and shareholders are prepared to try over and over again. at best M&As do no harm and their outcome is arbitrary. 1)1 it has gained significant momentum over time. For an analysis of the latest wave see (Moeller et al.4 In this paper we explore why companies. Brealey & Myers 2002). 1989). but no reliable data exists. 3 The cyclicity of the phenomenon remains among the most unsolved problems of corporate finance so far – despite the vast research carried out on the issue (Gort 1969. 1 -2- . an aspect that M&A research has not explored to date.2 We are not surprised. because they are the most readily available. For a discussion on availability see also (Kummer 2005). We refer to M&A figures of the United States. But M&A activity has always taken place all over the world. Tichy 2002). 2003).3 particularly when M&As in the previous wave – and even the ones before that – may have failed. not only on a small scale but also periodically with great magnitude. 2 For a review of studies on the success/failure of M&As see (Jensen & Ruback 1983. however. 4 For a comparison of the success rate between the 1920s and the 1960s/1970s wave see (Borg et al. but if we accept the failure rates in various studies measured with different approaches as a fact. 000 10. Note that these data stem from different sources that are not consistent – for extensive comments on the data and its drawbacks see (Golbe & White 1988). Because there is a time lag before M&A failures are realized. Source: 1887-1889 (Conant 1901).Number of M&A 12.000 8. But when failures are realized on a critical level. 1890-1894 (Thorelli 1955) 1895-1953 (Nelson 1959).000 6. 1954-1963 (FTC 1971).000 4.000 2.000 0 1887 1893 1899 1905 1911 1917 1923 1929 1935 1941 1947 1953 1959 1965 1971 1977 1983 1989 1995 2001 Year Figure 1: Merger and Acquisition Activity in the United States (1887-2005)5 We explain why M&A waves happen with such a magnitude despite their high rate of failure. 5 -3- . 2). the M&A wave can build up. the M&A wave collapses quickly as we can see from the life cycle of M&A waves (see fig. 1964-2005 (Mergerstat 2006). Periods with little M&A activity (near the natural rate) are used by the whole industry to develop new concepts and strategies that will later give rise to new M&A transactions. 4 5th Wave (1992-2002) 0.1. 2. Brealey & Myers 2002. 2 Why Companies and Managers Choose M&As Plenty of rationales for M&As have been proposed thus far. The conclusion includes a summary of the vicious circle of M&As and examines whether unrealistic hope always leads to failure. Walter & Barney 1990. especially how they are (mis)interpreted.8 3rd Wave (1955-1975) 1st Wave (1897-1904) 2nd Wave (1918-1932) 0.2 Average Wave 0 -14 -12 -10 -8 -6 -4 Years -2 0 2 4 6 Fig.6 4th Wave (1980-1991) 0. Weston et al.7 Most of these conventional lists lack a categorization of the strategic intentions which are often labelled as “rational” explanations for M&As. When internal growth initiatives do not materialize.2 Level of M&A Activity 1 0. or there are no other organic growth options. M&A transactions prove to be the only way to create growth. We then discuss why companies and managers are convinced and overly self-confident in trying M&A transactions again. Weston & Weaver 2001. Source: (Steger & Kummer 2003b) For enumerations of motivations for M&A see (Trautwein 1990. 2001.8 whereas “irrational” explanations focus on individuals. especially top managers who engage in ”empire building” and the like.1 The quest for growth and pressure to grow The primary motivation for M&A deals is the quest for growth. Bruner 2004) 7 6 -4- . Whichever explanation might be the most appropriate. 2: The Life Cycle of Merger and Acquisition Waves6 The theory will be presented as follows: We explain why companies choose M&As and we look at possible reasons for failure. the reasoning behind each M&A transaction seems mixed and caused by a variety of motivations simultaneously. In this situation. People. the thinking goes that if other managers can make it work.9 For listed companies the external pressure for more growth can be so immense that it cannot be realized by organic growth through internal projects alone.2 Being a consolidator When the industry is in a period of consolidation.11 Also. evidence that is of questionable validity. however. Often. can be totally different. The demand for double-digit growth from analysts and investors becomes hard to satisfy.3 Testimonials and success stories Testimonial evidence about businesses at conferences and in the media tell us that some M&As have (supposedly) been a huge success. managers and academics in the field. Companies also engage in M&As in order to survive (“bandwagon effect”)10. the reasons for M&A failures are not 8 9 Only (Steger 1999. the fear of being left behind spreads. timing of the deal and strategic intention. tend to accept testimonials. Bower 2001) have proposed such categorizations so far. 2. 3 Why M&A Deals Fail Why do M&A transactions fail so often? The reasons are manifold. Schenk 1996. People tend to demand little follow-up evidence and do not look at the long-term success.g. and transaction factors. industry. Fauli-Oller 2000) 11 (Stanovich 1998) -5- .External pressure can also force managers to initiate additional M&A transactions. the proposed critical success factors for M&As are as numerous as the consultants. even if they might have failed in the past. 2. I can do it too. In addition. can add complexity to the mix and cause significant problems. e. in addition to the interdependency of factors. life cycle of the company. M&A transactions remain the only solution. Promoters of M&As come up with alleged opportunities and the motive to buy companies in order to prevent competitors from doing so is always difficult to evaluate. (Slywotzky & Wise 2002) 10 (van Wegberg 1994. But any given situation. firm-specific problems. when these success stories are examined in detail. it is often difficult to measure whether they really were successful. and as other competitors consolidate and challenge a company’s market position.12 The fact that change is happening all the time. This is far from being well understood otherwise the success rate of M&As would have improved drastically as a result of defining these success factors. most authors neglect this restraint and take this condition as already given which might be a mistake. Let us take a look at the task difficulty and the different phases of an M&A transaction from pre-M&A. 2002). Therefore. M&A to post-M&A phase. project management. Early on in the integration phase. First. For years to come. see (Kruger & Dunning 1999). 3). 14 Note that. i.15 the ease of integration is underestimated. but are not sufficient to make the entire M&A transaction a success. -6- . Although the speed of integration is often seen as one of the most critical success factors. 13 There is no widely accepted general model for steps and phases of M&A transactions. It is often predicted that change will be faster and easier than what is realistic. 1991. We often see M&A deals that even neglect the few success factors of M&As that we do know. We see that the impediments of unrealistic expectations. distrust and group dynamics all play vital roles. the organization remains split in two separate groups – the former employees from company A and those from company B. 3. (over)confidence. Integration takes time and it is painstaking – this is where success can once again be spoiled. we take quite a different approach to the reasons for failures. promoters and external advice. the acquiring 12 For studies on success factors of M&A see (Datta et al. 15 In some studies. While the first steps are relatively easy.13 The chronological order of the M&A transaction goes hand-in-hand with task complexity (see fig. These labels survive. speed of integration comes first and is mistaken as the cure-all.16 The profound changes needed for success are more difficult and take much longer than originally thought. the selection of the “right“ target is already the conditio sine qua non for a successful M&A transaction.1 Unrealistic expectations The main reason for M&A failure is unrealistic expectations.e. 1994). Datta & Puia 1995). see (Buehler et al.14 The inertia of organizations and people is underestimated. For the necessary strategic and cultural “fit” of acquirer and target or merging partners see (Shelton 1988. i. Second. Cording et al.e. 2001. The search for potential targets is relatively easy and even the acquisition is as such (when one pays too much for the target company anyway). People especially think that desired changes are more profound and easier than is feasible. Resistance shows up and with resistance comes delay. However. Nowadays. Especially in M&A “cookbooks” speed management is seen as the most important ingredient for the rout to success. The changes implemented during post-merger integration projects usually only scratch the surface. later ones become more complex. the goals of M&A deals are often unrealistic. should not be mistaken for strategic intent. They overestimate their capabilities in an array of fields and are not aware about this fact. Datta 1991. making M&A deals work is a difficult task and many managers underestimate this fact. 16 There is a optimism bias with regard to expected speed and success to realize desired aims. Gadiesh et al. in comparison with the obstacles to be mastered during the actual integration phase. But it is more a question of “do the right things fast” rather than “do anything fast”. The search and acquisition phases are necessary steps.clear. content. speed. of course. mid. employees.and long-term time frames. when using net present values as the basis for company valuation the acquisition price is overrated. Hence. The low-hanging fruits are probably just 20% of all synergies and the rest are “strategic” synergies that have to be realized in the long run. in the very beginning. Additionally. s n ns . Search/Selection Pre-M&A (2) Integration Planning . like promoters. Realizing short-term goals are the easy and quick wins. Task Complexity &A t-M tion s Po ntegra I Pre-M&A (1) Potentail Targets . therefore. As the integration progresses more difficult obstacles surface. Often as a consequence. simply because their company is bigger in almost every respect – sales. Premiums paid can hardly ever be recaptured.company and their management exercise more power. synergies and the like become harder to realize.17 Free cash flows are simply wrong and. Synergies are also frequently overestimated – they look good on paper but are not realized as calculated. some rewards of M&As are surely grasped. most concepts structure the integration process and its goals in short-. the amount spent for a target is too high or one of the merging partners is overvalued. Suppliers will try to secure their piece of the pie and will court executives. diluting the original plan and its targets. -7- . Unexpected compromises must be made with unions. 17 (Alberts & Varaiya 1989). Erroneous evaluations can also be produced by the perspective buyer: the acquiring company judges the target with its own (and always different) perspective. Price Evaluation A go ge M& Ne e Dili Du n tio ac . branches and costs. employees and other stakeholders. Of course. Tra tiatio nce Time Figure 3: The Process and Task Complexity of Mergers and Acquisitions Hopes in M&A deals can also exceed what is feasible. this procedure should create motivation for further endeavors but the ultimate success or failure of M&As come in the later stages of integration. But far too often the thin line between overambitious and unrealistic is crossed.18 they turn to M&As.21 In addition to this situation. controllable and desirable22 managers will renew their efforts to achieve these unrealistic goals and undertake further attempts to achieve them. or their company’s.23 When these expectations prove to be wrong. The management just tries to make the impossible happen. 1987) 21 (Steger 2002) 22 (Lecei et al. But then the transaction has explicitly been aimed at these profound changes. This leads to further trials and the possibility of another failure. Instead of solving the real.19 It is often thought that M&As might also convert the company’s image. If the goals are unrealistic to start with. Not even a more capable management could realize them. failure cannot be avoided. But if these goals are perceived as important. These options are presented as the company realizing its vision.20 M&A is one of the most distasteful events in the life of today’s manager. agenda of extraordinary growth.Managers also often believe that the M&A can be compensation for a floundering core business and a lack of vision. M&A is a situation that is unfamiliar and exceptional causing distress for both managers and employees. In general. the price to be paid 18 19 (Hammer 2004) In some cases. Instead of abandoning the M&A transaction. The high emotional involvement of management and absorbed cognitive resources further increase the likelihood of failure. Undoubtedly. M&A is indeed a viable way to shake up companies and transform them. managers are overly optimistic and predict outcomes for themselves that are too favorable. Unfortunately. M&As can be helpful in being a distraction from the real problems that the company experiences. these more realistic goals rarely coincide with either their. as well as its overall business. They hope that deals will solve other problems such as improving parts of the company. Armor & Taylor 1998) -8- . the failure remains too high for the premiums paid. the unrealistic expectations cause further distress and deplete cognitive resources. and sometimes operational. Participants do not to walk away from deals during due diligence. Deals have to be ambitious. Unattainable goals should be abandoned. Resources devoted to these goals are almost always wasted. “Realistic” plans alone would probably be not enough to convince the board of directors and shareholders to pursue an M&A transaction. Hence. 1994) 23 (Weinstein 1980. With realistic parameters. with more realistic goals they could succeed. the advantages of M&As are far smaller than the average premium paid. problems or innovating the business. For examples and explanations on such these “transformational” M&As see (Steger 1999) 20 (Ivancevich et al. managers remain motivated by using a variety of techniques to maintain their unrealistic beliefs and they will continue to try and succeed. especially when a new corporate name is chosen. McKenna 1993. Of course. 27 Managers who are optimistic usually have greater psychological well-being and other positive attributes which might relieve cognitive depletion.25 Belief or hope in the possibility of success seems to be another powerful ingredient in achieving success. on these values. to some degree. Despite the widespread belief that all obstacles can be overcome as long as one tries hard enough. These issues are pushed especially hard by the promoters of M&As who promise fast. this is not true. 3. dramatic and successful change. managers would hardly make the efforts necessary for M&A projects. speed. But then the goals have to be raised as well – they not only remain unrealistic but can also become even more unrealistic. This is also the case for M&A transactions. ease and other effects. confident managers who try are more likely to succeed than are managers lacking confidence who also make the same attempt. culture is built. Having optimism or positive expectations can also help. The “American Dream” and U. are crucial ingredients for a potential success. Those who do not even make the effort cannot succeed but neither can they fail.“ 26 (Peterson 2000) 27 (Armor & Taylor 1998) -9- .S. First. and the achievement of its goals. M&A efforts are often doomed to fail from the very beginning due to unrealistic expectations.24 If this was not the case. They are able to convince other people of the chances. Second. Confidence in the success of an M&A deal. the additional efforts to overcome these obstacles would not have been made. especially concerning these issues: amount spent. Confidence can then make the critical difference between a make or break situation.26 Hope differs from confidence with respect to the locus of control – the latter depends upon the abilities of managers while the former depends upon some indeterminate circumstances and factors of supportive future situations. the belief is widespread that success depends only on effort and willpower. Without confidence.2 (Over)Confidence Every entrepreneurial decision aiming for returns bears certain risks. Those who believe that they can succeed are more likely to make the effort. benefits and success 24 25 (Bandura 1977) In many cultures. as well as the rewards of change. The confident managers are also more likely to succeed because they will also work harder to overcome difficult obstacles. easy. they have the opportunity to succeed because they try. There is also a German saying: “Where there is a will there is a way. In brief.is often raised in order to convince the target’s shareholders and management of its viability. Take into account managerial overconfidence (Bradley & Korn 1982) when discussing the failures of M&A transactions. Hitt et al. Some things are simply impossible to execute. management capacity or financial assets. that turn out to be wrong can be costly. People may lack the necessary capabilities and resources. Thus confidence. The acquirer’s management seems to know that with the resources available.g. however. especially in bidding contests. of course. Zajac and Bazerman (1991) offer the existence of "competitive blind spots" as a partial explanation for high acquisition premiums. hope.32 If the CEO has been very successful thus far. hope and optimism are necessary to some degree and useful for M&A success but when managers strive for the impossible or the unlikely they are simply being overconfident.31 CEO overconfidence is often seen as an important factor during bidding. Barnes 1998.of the M&A transaction. optimism and positive expectations can have positive effects on M&A success. Roll (1986) formulates the well known “hubris hypothesis” that managers overestimate their own ability and over evaluate target companies. (1998) see overconfidence as a stimulating force which can speed up the acquisition process and reduce the consideration given to integration issues – this causes managers to feel more in control of the situation as a result of their prior experience or expertise. especially when expectations are unrealistic and cannot be realized no matter how hard one tries.30 Lys & Vincent (1995) use overconfidence as one explanation of the decrease in AT&T shareholders’ wealth by between $3. Indicators that the task difficulties are beyond one’s abilities are overlooked. Overconfidence may lead to an illusion of control and hence to premature solutions with less thorough evaluation of acquisition candidates and little consideration of integration issues. belief.28 Optimistic beliefs. Hayward & Hambrick (1997) show the effects of recent media praise for the CEO and the CEO’s self-importance on M&As. i.e.” 29 (Peterson 2000) 30 (Duhaime & Schwenk 1985. the winner’s curse. who will dare to challenge him? Something called the “Jack Welch syndrome” was attributed to the Honeywell acquisition. e.10 - . knowledge. Jemison & Sitkin 1986b) 31 (Varaiya 1988.9 billion and $6. Heaton (2002) identifies that excessively optimistic managers and efficient capital 28 Also (Szulanski & Winter 2002) think: “In some managerial contexts.29 Confidence. Giliberto & Varaiya 1989.5 billion caused by AT&T’s acquisition of NCR Corporation in 1991. they themselves cannot fulfil the tasks of an M&A transaction. There is the risk of overbidding. overconfidence and over optimism are great things. Goeree & Offerman 2003) 32 (Fanto 2001) . In particular.34 Böhmer & Netter (1997) find a weak support for the hypothesis that managers resist takeover bids because they are personally more optimistic about their firm’s prospects under their control versus the company being in the hands of the bidder. people who should be especially concerned about overconfidence do not seem to care and are likely to be overconfident. incompetent people seem not to recognize their own inability. Even when diversifying into related fields of business. Managers expect to reduce the task difficulty by utilizing the promoters’ services. Promoters convince managers that they can succeed.35 The successfully mastered first (and easy) phases of M&As foster the illusion that people are competent enough to succeed in the following phases as well. 34 (Duhaime 1981). and therefore do not invest in positive net present value projects that must be financed externally.e. This could be another reason why there are a disproportionate number M&As failures – the overconfident managers try whereas the realistic ones do not.36 They are more prone to engage in projects and persist in efforts that are likely to fail. 35 A certain naïveté and optimism might be a must for entrepreneurial activity in general and for M&A specifically. Thus. On the other hand. i. rather than the maximization of shareholder wealth. optimistic managers see their securities as undervalued by the markets. the initial success contributes to overconfidence. They have a vested interest in M&As and push companies into M&A deals in order to offer their services.markets are confronted with an under.11 - . Xia & Pan (2006) incorporate overconfidence in their game ‘theoretical real options framework’ to model the dynamics of takeovers.33 On one hand.3 Promoters and external advice Managers rely heavily on “promoters” to initiate. The enormous difficulties of M&As tend not to become fully apparent until the integration phase. Promoters for M&As are investment banks and top management consultancies. Promoters have a signalling effect 33 Also (Malmendier & Tate 2003) demonstrate the relationship between overconfident CEO’s and suboptimal investment. Danbolt (2004) suggests “that any target company cross-border effect may be due to managerial overconfidence or managers of cross-border bidders pursuing the maximization of personal utility. structure and carry out the M&A transaction.and over-investment trade-off. . 3. optimistic managers overvalue their own projects and might invest in negative net present value projects. managers are overconfident in possessing the management skills needed in the new business. to a greater extent than do domestic bidders”. otherwise most people might restrain themselves from making the necessary efforts to do M&As. experience and a record of success they make future success more likely. (2003) explore the effects of the financial advisors’ reputation in takeovers. bankers will be happy to arrange it. as well as the share of the total takeover wealth gain accruing to the bidding company. promoters believe in their (own) success that is often based on false self-evaluation.12 - . There is nothing wrong with confidence. They frequently fail to turn M&A transactions into successes. hope and belief. Evidence however tells us that promoters are far from being omnipotent. and those with dominant personalities. Overconfidence can be found on both sides with managers and promoters. The self-centered qualities one needs to be promoted in these firms do not necessarily contribute to the company’s success. There is considerable potential for conflict of interests regarding banks involved as M&A advisors. Financial analysts judge the deals done. If there is the need for a capital increase to finance an acquisition. Kale et al. are hired. increases as the reputation of the bidder's advisor increases relative to that of the target. But success becomes less likely when the same qualities are unjustified and totally unwarranted. They also provide the much needed additional capacity to manage the M&A integration phase that companies usually lack. restoring hope and providing motivation – all of which are essential factors for success. Hence. Promoters can fulfil a useful function by fostering confidence.37 There is another factor – advice given by promoters is not always followed by managers. The ultimate responsibility lies with the management. Bank’s lending operations are interested in giving loans to finance a transaction. When these qualities are based on competencies. or not. Promoters see fees and projects sold as their criteria for success.38 The bank’s trading arm would love to use insider information to make gains in merger arbitrage.to supervisory bodies that the M&A transaction makes sense and will work. Promoters more often recruit university graduates who are confident. Fund managers decide in which companies to invest. This recruitment bias might be true in a few cases and a self selection by applicants might already have taken place. It is critical to examine the measurement of success or failure of the various participants. The self-assured candidates. The bidder advisor’s reputation is also positively related to the probability of bid success. They also find a positive relationship between the total wealth created and the bidder and target advisors’ reputation. There is no doubt that these recruits have received excellent grades but those provide little indication about their capabilities to make M&A strategies work. They document that the absolute wealth gain. The important goal for 36 37 (Kruger & Dunning 1999) (Peterson 2000) . 39 Rumors spread rapidly. They might prefer complicated M&A projects where. Saunders and Srinivasan (2001) find that companies are paying higher merger fees to investment banks when they have had a prior relationship. employees are among the stakeholders who are often treated the worst of all. The manner in which. stakeholder management is performed poorly. 39 38 . all over the company. The only stakeholders who are usually treated well are shareholders in an effort to prevent them from selling their shares and because their votes might be needed in general meetings. Castro & Fontrodona 2002. So. Kay & Shelton 2000. in the end.e. (Allen et al. It is interesting to see that companies rarely switch their M&A advisors. an appropriate amount of confidence is a crucial ingredient for success. Second. either to approve the M&As transaction or to re-elect corporate officers in the future. But. They do. Third. work with other colleagues. work for a different boss? Will the entity of the company that they work for be divested? These are uncertainties that can last quite some time. see that firms are more likely to switch their advisors if their prior advisor has not been a top tier investment bank. In addition. employees are informed about the M&A transaction is another essential point.4 Distrust At the grass root level. Schweiger & Weber 1989. For further aspects regarding employees and M&A transactions see (Davy et al. however. if people are fired the workload is not reduced which results in fewer people having to produce the same amount of work. insecurity among the staff persists longer than necessary. Fourth. they identify that there is no relationship between higher investment bank fees and acquisition performance. blame cannot be clearly attributed. 2000. 2002a) For communication with employees see (Schweiger & Denisi 1991). Is there the danger of losing their jobs? If not. 1988. if at all. the attitudes and moods of the employees are often quite the opposite of (over)confidence – namely distrust. how will their jobs and tasks be changed? How will the restructuring affect them personally? Will they have to move to another department. they decrease the employees’ trust in management and make changes more difficult. The Economist 2002b. there is uncertainty about what will happen in the future. integration plans are sometimes far from being settled. below top management. Risberg 2001) 40 (Rosnow 1987. This might contribute to the failure because. as previously mentioned. companies are often restructured at least every two years. 1988) shows the danger of rumors because if they are based on uncertainty rather than on facts. the M&A projects will produce “just another change program” that will not bring the desired outcome.40 Even months after the closing.13 - .consultants is that their integration services are needed and follow-up projects are sold. Why do so many employees feel a lack of confidence about M&A success? First of all. and at what point in time. i. 3. the board has the ultimate responsibility but that is shared and unclear. This means that incentive systems. Nevertheless. M&A is a quick way to realize that goal. First. The risks of such projects can lead to a company’s bankruptcy. the decision for an M&A transaction is made by the board of directors and the management team. 44 (McFadzean 1999) .45 4 How M&A Failures Are (Mis)Interpreted Above of all. Wright et al. 3.14 - . (2001) find that managers with high equity-based compensation pay lower acquisition premiums. (2001) show that risk-reducing strategies are subsequently emphasized as managers expand their stock ownership and that stock options have a consistently positive impact on firm risk taking and acquisition returns.The separation of ownership and management adds to the critical situation. In the worst case scenario even the CEO has to give up his position. There is a tendency to get carried away by group dynamics. are working. the failure of an M&A transaction has to be recognized as one.41 Managers can pursue their own goals to some degree. Fourth.42 Conn (1980) however finds no differences in the merger pricing policies by either owner-controlled or manager-controlled firms. acquire targets with higher growth opportunities and make acquisitions engendering larger increases in firm risk. Third.5 Group dynamics An M&A transaction is a situation where a lot of people and teams are involved. Whereas the final decision on large transaction is subject to approval by the shareholder meeting.g. In the case of a failure. But Datta et al. important projects do have an initiator. when properly designed.43 with all of the consequences that are inherent to group situations. Concerning growth however. But the measurement of success and failure is far from being solved. Also. coach or implementer on the management board level. the responsible manager will have to leave. participants in M&A negotiations often become committed to the deal regardless of its logic or benefit to the company. This is always the case when an M&As transaction becomes a success. e. at least when it comes to individual board members – everyone involved has a share of that responsibility. blame is often put on those who carry out the post-merger integration and not on those who decided to initiate the transaction as such. groups make more extreme decisions. when the amount or strategic impact is quite small. many resources are 41 For an exploratory discussion of M&A and corporate governance issues see (Steger & Kummer 2003a) 42 (Mueller 1969) 43 Although small acquisitions or divestitures can be exempt from decisions by the supervisory board. Second. Ex ante.44 especially with big M&A deals where there are very difficult activities in which companies can engage in. But postM&A. when the managers and companies themselves see their transactions as failure. Although unrealistic expectations made the failure inevitable. While managers often perceive their transactions as successful. after the integration phase is complete. for the success or failure of a transaction to become apparent. always claim their transactions to be a success. Therefore. some frequent acquirers like Cisco and General Electric have first been hailed as successful acquirers but. at least publicly. For most M&A transactions the identification as a failure is very unlikely in the first place. Empirical evidence suggests that managers. they would stop trying. more promising way. If failed M&As had a prognostic value for the likelihood of future transactions’ success. The thresholds are far from being fixed – they can vary during time and can also be raised. they usually do not interpret them as the result of their inability to succeed. controlling is often neglected. Even.46 Managers try again because they do not accept defeat easily. It is only a question of habituation. Also. there has been much doubt about whether their transactions were actually successful. a difference between the manager’s judgement and those of experts and studies is possible because on one hand the measurements for success or failure of M&A transactions are ambiguous. The failure of M&A transactions is not seen as inevitable. company to company or industry to industry. a learning curve is seldom experienced. as of late. If this were the case. then companies and their management might take them at face value and would restrict their M&A transaction activity seeking some other.g. Certain thresholds have to be reached until a transaction is seen as a failure. Strategic alliances are not the natural alternatives because they are not a guarantee for success either. For example. they will find explanations and exculpations for the failure. 45 46 (Jemison & Sitkin 1986b) (Bleeke & Ernst 1995) . organic growth initiatives. There is a huge time gap between the closing of the deal and the “end” of the implementation. it takes quite some time. Also during the integration phase a great deal of effort is usually made to make things work. On the other hand. These thresholds can differ from case to case. outsiders think of them as being failures.15 - . e. if ever.devoted to the M&A process in identifying and evaluating potential candidates. By placing 47 48 (Weiner 1986) If they were to blame M&As in general. had only tried harder or devoted more resources the M&A transaction would have become a success. If one had only been better prepared.47 Both types help managers avoid facing facts once again.16 - . changing markets. .4. The complex dynamics of M&As allow for various explanations. Interestingly. failure is often viewed as the result of external factors. were not up to it. attributions for failure can be either internal or external ones. economic outlook and situation. Of course. There is a cognitive dissonance between the desire for a successful M&A and the reality of an unsuccessful deal that is balanced by denying the wish and lowering the importance of unmet targets. In addition. 49 (Ryan 1976). Internal attributions for failures are rare but can be associated with issues such as a lack of preparation. Rather than make this conclusion about M&As in general. M&A transactions are perceived as being difficult to do. Managers often choose a reason that can be changed next time thus restoring hope for the next M&A deal and success in the future. The process was so difficult because the particular integration strategy. 4. There are plenty of factors in today’s business environment to choose from: a change in business indicators. the acquirer or merging partner blame only task difficulty for the specific situation. made more elaborate plans. Another external attribution for failure is the immense task complexity.1 Internal attributions In general. the exceptional successful M&A transactions exist and can be used for promotion.2 External attributions External attributions are certainly the ones that managers prefer the most – they blame external factors which are the most unstable elements surrounding M&As. or about the future. as well as the strategy of the failed transaction. while success is usually attributed to oneself and his own personal efforts and capabilities.48 It is the classic example of blaming the victim. promoters of M&As have a vested interest in blaming the acquirer or the merging partners for causing the failure instead of calling their own services and performance into question. choice of the wrong consultants and investment bankers or choice of the right ones who performed in an inferior manner. planning or effort. or other factors.49 Managers might also conclude that this M&A deal was not so important after all. they would destroy a large part of their business. All of these reasons allow the acquirer to blame something that can be changed next time. reactions by competitors. 3 Failures as near wins Managers can interpret M&A failures as a near win. As previously mentioned. or merging partners. The range of concepts available is enormous and is constantly growing – they can at least be repeated under new guises. the unlucky acquirer can chose another concept to try next time.51 Often. Switching concepts and promoters is a preferable tactic psychologically because it relieves the acquirer. 5 Why Companies Are Convinced and Try Again So why should companies try M&As again. they simulate the illusion of control. But the true make or break lies elsewhere. not in planning the integration and especially not in finding synergies that can be identified by almost everyone. Thus. This is especially true when they acquire or merge with a better target or partner. 4. They are like gamblers who believe they will win next time and explain their losses away as near wins. these concepts are the kind of “one concept fits them all” which should make one sceptical immediately. Ask any promoter and they will willingly come up with some sound new concept “tailored” to meet the needs and specifics of each M&A candidate.52 Managers might interpret a failed M&A transaction as a near success and only count successful deals as proper ones. 1986b) 52 (Gilovich 1991) . only accepting wins as proper results. the chances for the next M&A attempt to become a success are restored.17 - . see (Byrne et al. at least on paper. from any blame for the original failure except possibly that they displayed some naïveté in choosing obviously incompetent promoters and an inferior concept last time – they were simply tricked by the promoters’ good shows at the “beauty contest”.50 If managers change promoters and use an enhanced – or totally different integration concept – for the next M&A deal. it can become a success.blame on that specific M&A transaction and its implementation. M&A promoters heartedly recommend changing concepts – that is what they are paid for and it brings them new business from new clients. shift the responsibility back to promoters. The main selling point of these new concepts is that they make success almost calculable and automatic. however. 2002) (Jemison & Sitkin 1986a. particularly after the first transaction was most likely far from being a success? 50 51 McKinsey has blamed Swissair for not realizing its strategy correctly. promoters of M&A might be inclined to blame the acquirer or merging partners for the failure. This solution also addresses task difficulty by allegedly reducing or eliminating some difficulties in future M&A processes. Managers can. This risk can. M&A strategies seem to become more popular from one generation to the next. wealth and fame are so powerful and the glamour of M&A transactions is tremendously alluring. i. Internal departments. But when. promoters of M&As continuously lure clients with promising opportunities. undermines the reinforcing power of these rewards and provides no compelling basis for retrying M&A projects. Doing the deal then becomes a success in itself.18 - . undelivered rewards. M&A strategies. Greater leeway is given to managers if some transactions are (thought to be) successful. i. the career of managers is at risk as well. The anticipation of a positive outcome is almost the same the second time as they were for the first M&A attempt. The only thing managers can try and do is to handle some factors differently this time. Realizing an M&A transaction is high risk and is even perceived to be so by managers because it could be the end of their careers. Additionally. the final positive consequences are rarely experienced. the origins of success most likely remain misunderstood. Learning theory tells us that repeated failure. The M&A transaction and being in the press can become a thrill for managers. come up with new ideas – M&A transactions often serve as a fast track to realize them. like strategic planning and business development. a successful M&A transaction happens this event acts as an intensifier and managers pursue an even more active and ambitious M&A strategy. however. This positive illusion53 motivates future M&A projects and efforts. Some managers are involved only once in a lifetime in an M&A project. the premium paid for targets is not risk adjusted.e. A new management (generation) will try again. companies will try again. it remains the only viable way for growth.5. their business. Managers are convinced that these goals are desirable and above all achievable. under control. be reduced a little by shared responsibility in the group situation. It is also a question of management styles. After all. they succeed to keep other activities. Companies are particularly likely to try an M&A transaction again if the first attempt is successful and has had the expected results. After all. power. . But when a real M&A strategy is pursued. however. How much can be gained by a successful M&A transaction? How likely is the initiative to succeed? How much can be lost? Even when the expected return or benefits from the transaction are realistic. once in a while. As long as the motives behind M&As persist. Even if the track record from past M&A transactions is at best mixed. The striving for profits.1 It’s the same aims The first reason for why companies try their luck again with M&A deals is that the outside pressure to grow still prevails.e. often lack a risk-return-analysis although managers realize the high risk. In the rare case of a success. search for targets. e.54 If a process has already been started. The rewards. Another reward is the mere decision to pursue an M&A project. Even minimal efforts to initiate an M&A. due diligence and the acquisition are relatively easy compared to the efforts required in the future during the actual integration. one will surely find a few. In any case. If one has already made all the necessary efforts to get to this stage. It provides an initial feeling of control and efficacy. However. it is prone to be completed. The first incentives during the M&A process can be the courting by the promoters of M&As. whether they are perfect fits or not. certain phases can be successfully completed and the expected rewards for them are delivered. it is better to buy a company than to have the competitor do so. There are interesting dinners. in addition to confidence that the failures of M&As will be avoided this time around. When other competitors are paying high premiums.e. stopping an acquisition process can be sold to the public as a strong reason not to overpay. There can be more proximate rewards that are actually delivered during the M&A process early on. even if the new M&A transaction becomes another failure in the end. thus fueling further enthusiasm – after all. this action might especially restore the investors’ 53 (Taylor & Brown 1988) . Thus. impressive slide shows and sumptuous beauty contests held for executives and company councils. The whole M&A process is so demanding (and unlikely to be ultimately either pleasurable or successful) that perhaps it is no surprise that people feel the most confident before they actually begin the process.g.The distant goals or dreams of M&As probably cannot serve as such a powerful incentive for the acquirer’s desire to try again and to take the trouble of yet another M&A. why should they abandon the process even if tremendous difficulties and risks have been identified? The psychological costs of a “walk away” are high. The decision is often mistaken for an act of control because there is a mistake in believing that everything can be controlled and planned – something which is actually feigned by promoters. Investment bankers and consultants show significant interest in and pay attention to managers – they invest quite a lot of resources to acquire projects or to initiate transactions. even before the company decides to actually pursue such a project. even if the premium to be paid cannot be justified. can be rewarding. support the enthusiasm for yet another M&A project. Most people need and enjoy the feeling of certainty and being in control. During these first phases ample reinforcement is provided to the acquirer. scheduling a meeting with promoters. i. The decision itself already leads to positive effects and is seen as a first step to success. Another M&A incentive can be that if one looks for some target to be acquired.19 - . some fits can be found primarily due to the fact that they were hoped for. The early stages. Holl & Pickering 1988) discuss the causes and consequences of abandoned mergers. Haleblian & Finkelstein 1999.2 New concepts and strategies New concepts and strategies surface which can be realized with the help of M&As. But we should be aware that the run on fads and “herd behaviour”.55 Managers might think that they have gained experience in mastering M&A transactions or suppose that they have learned from their mistakes in the past.3 Divert from other M&A deals Managers might initiate new M&A transactions in order to divert attention from the failures of the last transaction.confidence. Prendergast and Stole (1996) show that managers. For a further discussion of the issue “learning to acquire“ see (Leroy & Ramanantsoa 1997. For the reaction of target companies on failed takeover attempts see (Chatterjee et al. there are so many other ones to make – each M&A transaction is unique and similarities with other deals are few. With this diversion technique they manage to shift the focus and attention of board members and investors to the new M&A transactions. because they did not have that insight in a timely fashion. the failures from the past are not identified.20 - . in an effort to appear as fast learners.4 Serial acquirers Companies may want to solve problems or fill gaps where one M&A transaction is not sufficient. 5. They therefore become serial or frequent acquirers and figure out an M&A process by trial and error. Companies might pursue active M&A strategies and buy companies frequently. 2003) 55 There is a growing number of literature dealing with the topic of learning and M&A. exaggerate their own information and become unwilling to change their decisions on the basis of new information. despite the fact that these transactions are far from successful. New transactions make the comparisons even more difficult and transparency is avoided. 5. Hence. There is widespread belief that they will have learned their lessons from the earlier attempt so that they will at least avoid the mistakes made previously. Not all of these transactions have to be failures or will be recognized as such. Hayward 2002) . Standard concepts are unlikely to solve the problem anyway. 54 (Pickering 1983. Zollo & Leshchinkskii 2000. even if they do work in some cases. as well as having realized their mistakes. But even when they have learned from past transactions. whereby people just copy what others do will not lead to abnormal value creation – that lies only in true uniqueness. 5. a M&A transaction produces reinforcing feelings. . Already the preoccupation with the possibility of. Third. and rewards of M&As. profits. ease. 4). amount. the memory of desired targets is supported by attention. cost cutting. the circle goes as follows: Pressure to grow and overconfidence by executives and promoters lead to unrealistic expectations about the speed. choice of the wrong target or the payment of a too high premium. a well-defined time frame and intention.5. the memory of negative effects is diluted by a lack of intention. Moreover. Concepts are diluted by a series of necessary compromises and an adaptation to reality. e. measuring results in the future might prove to be impossible after the integration. a diffuse time frame and a desire for it not to have happened. Second. there is a much better possibility of remembering the successful M&A or its positive points than to remember the negative transactions and their particulars. or to neglect the negative aspects and to overemphasize the positive ones. the time frame for an M&A transaction is distinct – it is defined by the project plan with all its milestones whereas the time frame afterward is more diffuse. companies monitor progress and change more closely during the M&A transaction and stop such exhaustive measurements later on. some M&A projects turn out to be resounding failures. especially early on in the integration process where goals are relatively easily met (the quick and easy wins). Unless there have been no mistakes made at this point. In brief. Fourth. some successes are realized. How can we explain the high failure rates when at least every large M&A transaction is carried out with the support of promoters and most of them still fail? 6 The Vicious Circle From Pressure to Failure All of this amounts to a vicious circle from pressure to failure (shown in fig. etc. This prompts the company to commit to M&As and give it a(nother) try. the integration phase is where the “make or brake” takes place and resistance shows up. and the ultimate decision to do. First. On the other hand. sales and such things are intentional but cost growth and losses are not. In general. Companies and executives think that promoters are experienced in M&A projects because they are specialists in these activities and can make the transactions a success. As a result.g.5 Overemphasizing the positive deals and aspects Another aspect for new M&A deals is a tendency to forget.21 - . On one hand.. why do companies and executives give them another try? First.Pressure (internal/external) to realize growth (Over)Competence of executives and promoters Unrealistic Expectations about acquisition price. some M&A transactions may turn out to be successes and act as intensifiers. etc. . They will then try to degrade defeat by explaining the failure away using various attributions. While an M&A transaction might have been successful in the very beginning because they could at least acquire the desired target failure ultimately occurs. it takes time to realize that their M&A strategy is unsuccessful. and executives might feel. due diligence. bids. Fourth. even when they do realize their failures. there is plenty of room left for internal and external attribution. These attributions distract from the unrealistic goals that were the reason for the failure in the first place – they can even allow commitment for further M&A transactions. The projects therefore have to overcome significant thresholds to be recognized as failures.22 - . negotiations. failed M&As actually add to the pressure to grow profitability causing the circle to start all over again. worse off than before. the company might be. other M&A deals might have taken place there as well. they have to realize that their M&A projects are failures to begin with. speed and other apsects Initial Efforts / Commitment to M&A Meetings. Third. These attributions lead to the conclusion that after all the next M&A transaction will be a success. Sixth. a change of management takes place. In the meantime. Point-of-no-Return Decision for/against M&A transaction Resistance to Success Especially during post-merger integration Failure External & internal attribution for failures Figure 4: The Vicious Circle of Mergers and Acquisitions When most of the M&A projects turn out to be failures. Second. Fifth. 7 Can the Vicious Circle be Broken? How can managers and companies break the vicious circle? They should take a reality test concerning their expectations and not be carried away by the dynamics of the M&A situation. especially for innovators and business leaders. When these costs are added to the calculations. in line with a corporate strategy. to realize strategies in certain contexts when they are carried out properly and thoughtfully. When the costs and benefits of unsuccessful M&As are added there is an immense 56 (Bradley & Korn 1979. the key is the way in which they are approached. The tremendous value of success may more than offset the long odds against succeeding. it does not follow that four attempts will ensure success or that the probability of succeeding on the fourth attempt (following three failures) is greater than 25%. and a sound tool. the function of dreams and visions – desirable if they are realistic expectations – are necessary human drives.56 They should also create transparency – internally and externally – by communicating expectations and influencing factors. management capacity and potential loss of customers. Is there not always a chance of success. One should also be aware of the different attribution modes to explain the failure. however remote? Although it is true that eventual strategy realization and problem solving may require multiple M&A attempts to succeed. Marks & Mirvis 2001) also call for a reality testing of potential synergies in and expectations to M&A transactions. it is difficult to argue the merits of launching one for the umpteenth attempt. A failed M&A transaction is not a catastrophe hence the success or failure of each transaction should be measured. Board members and managers have to strive for a true checks-and-balances relationship. not of certainties. Failures could. That is unless people have learned from the previous attempts. The costs of M&A transactions. In general. in order to establish a learning curve. Statistics alone are no reason for persistence. M&A transactions should also be analyzed ex-post in order to initiate a learning effect. Managers should create internal and external transparency of M&A transactions. reality testing is essential. contribute to the knowledge base of acquirers. e. But what is typically neglected in the calculation is the cost of another effort. An M&A deal should not be seen as a cure-all. On the one hand. . M&A transactions do not do much harm unless one is directly affected by its outcome. But on the other hand. and should.23 - . distraction of the organization. are steep. We do not want to sound too pessimistic. The good news is that on average. that fact does not imply that multiple attempts guarantee success. If the actual chances of success on a given attempt are 25%. the desire that M&As be a viable solution is not a false hope. M&As certainly are a good way. even successful ones. The false hopes syndrome is still a matter of likelihood.g. Jaffe. benefits not realized. the likely result is 0.A." In: Zanna MP (ed.) Advances in Experimental Social Psychology.25 * 500 – 0. arguing for another attempt is all the more difficult.. So.downturn potential. G... W.. Armor. Chicago. Even when the likelihood of success and failure could be influenced by experience – change it to 0. 1989. Jagtiani. Academic Press. P.W. Taylor.75. 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